An inconvenient problem.

According to the National Association of Convenience Stores, inventory shortages for convenience stores averaged about 1.6 percent of gross merchandise sales in 1988, up from 1.3 percent in 1987. Shortages are more serious in these times of increased industry competition.

To illustrate the seriousness of the problem, take a convenience store, also known as a c-store, that sustains a $5,000 inventory shortage. If that shortage is seen as lost net profit, assuming the store has a net profit margin of 3 percent on merchandise, sales must increase by $166,666.66 just to recoup the $5,000 loss.

Nevertheless, it is difficult to motivate store managers and employees to address the problem of merchandise shortages, primarily because they don't understand the cause of the problem. Many think inventory shortages are merely paper losses caused by inaccurate physical inventory audit counts. That is complete nonsense, and here's why.

Most stores conduct an audit every 30 days. Let's assume a new store is opened and the retail value of its opening inventory (01 @ Retail) can be determined precisely. During the next 30 days the store will sell some of that inventory (Sales @ Retail), and it will also purchase new merchandise to replace the inventory that was sold (Purchases @ Retail). At the end of 30 days the store can calculate the retail value of its ending inventory El @ Retail). That El @ Retail will be the retail value of the merchandise that ought to be in the store. The formula is stated as follows:

EI     Retail = 01 @- Retail +
                 Purchases @ Retail
                  - Sales  @ Retail

Once the EI @, Retail has been calculated, a physical inventory of store merchandise will be conducted to determine its retail value, and the two numbers will be reconciled. If the retail value of the physical inventory is less than the calculated EI @ Retail, the store has an inventory shortage. At that point the retail value of the physical inventory becomes the OI @ Retail for the start of the next audit period, and the cycle repeats itself.

If, as many managers assert, the physical inventory was inaccurate, it means there was no actual merchandise shortage, and the OI @ Retail for the start of the next audit period will be less than the retail value of merchandise that is actually in the store. At the end of the next audit period, or whenever an accurate inventory count is made, the store will reflect an inventory surplus that will offset the apparent prior shortage.

Let's illustrate by using an example. Assume our store had an initial OI @ Retail of $50,000, Sales @ Retail for the 30-day period were $38,000, and Purchases @ Retail for the period were $38,000. By using the following formula, we can calculate what the El (DU Retail ought to be at the end of 30 days.

EI     Retail = OI @ Retail +
                  Purchases @ Retail
                  - Sales   @ Retail
EI     $50,000 + $38,000
       - $38,000
EI     $50,000

Assume that the end-of-period physical inventory count is inaccurately done, showing $48,000 in store merchandise instead of $50,000. The incorrect inventory of $48,000 will be compared with the calculated El @.) Retail of $50,000, and there will be an apparent shortage of $2,000. This means that the OI @ Retail for the next audit period of $48,000 will be understated by $2,000. If, during the next audit period, the store again has Sales @ Retail of $38,000 and Purchases @ Retail of $38,000, we can once again calculate what the El Retail for this period ought to be. El Retail 01 Retail +

Purchases @ Retail

- Sales @ Retail El 48,000 + 38,000 - 38,000 El 48,000

That calculated El Retail will be compared with the retail value of the actual physical inventory count for the period. Assuming that the physical inventory in the store is accurately counted at $50,000, the store will show an inventory surplus for the period of $2,000, the exact amount of the prior shortage.

In summary, inaccurate inventory audit counts show up as fluctuations in inventory from audit period to audit period, with no net gain or loss in the long run. On the other hand, if store audits are consistently short, inaccurate inventory audit counts are not the true culprit.

Paperwork error is another reason often cited by convenience store managers as a cause of inventory shortages. During normal operations, periodic inventory adjustments must be made to account for markups, markdowns, damaged goods, spoiled merchandise, and store use items. Although errors in making these adjustments can cause the Sales and Purchases components of the formula to be misstated, and hence the level of calculated EI to be inaccurate, too much emphasis is placed on paperwork errors as the cause of shortages.

First of all, the concept of multiple unit pricing typically creates a built-in inventory pad that actually conceals shortages. For example, a six-pack of beer in a convenience store is usually entered into inventory based on its retail value if sold as a six pack. In reality, beer is often sold as individual bottles and cans, which makes the actual retail value of the beer greater than the amount listed in the inventory. Store managers should record markups in these situations, but they usually don't, thereby creating an inventory over age. In some convenience stores, particularly where beer, soda, and cigarette sales are substantial, the inventory pad created by this inadvertent activity can be significant.

Furthermore, many store managers say it is easy for an experienced manager to pad inventory by as much as $1,000 per month to either conceal unexplained shortages or make it easier to steal. One method is for store managers to "retail" invoices for less than the actual retail value of the merchandise received. When merchandise is delivered to a convenience store, the manager is required to report that the merchandise was delivered. The store inventory is adjusted to reflect the merchandise received based on the retail value of the merchandise the manager reports.

If, for example, a dishonest manager received a merchandise delivery with a retail value of $200, he or she could understate the retail value by reporting it at $196 but still sell it for $200. If that vendor makes one delivery per week, that seemingly insignificant pad of $4 would add up to $16 per month and $192 per year. If 25 vendors made deliveries to that store and each delivery was padded in a similar fashion, $4,800 in annual inventory shortages could be concealed.

THIS ILLUSTRATION USED A SMALL pad, but in reality, it could be much higher. Most companies have reporting systems that monitor gross profit margins, an area that would be affected by understating the retail value of merchandise, but managers are still able to shave invoices without being detected since some fluctuation from period to period between purchases and sales is normal.

Inventory can also be padded by manipulating markdowns. Assume that a case of beer sells for $15.25. There are 14 cases of beer in the store, and the manager is told to mark them down to $11.25 per case. Dishonest managers can falsify the number of cases on hand in order to pad inventory. For example, if the store has 14 cases of beer, the total markdown should be $56 ($4 x 14), and the retail value of overall store inventory will be reduced by that amount due to the markdown.

However, if the manager reports that he or she has 34 cases of beer on hand rather than 14, the markdown will be $136 ($4 x 34). By falsifying the number of cases, the manager has created a pad of $80 ($136 - $56).

Similarly, a store manager could also pad inventory by manipulating markups. If that same store manager is told to mark up beer from 11.25 per case to $15.25 per case, and there are 50 cases on hand, the total markup should be $200 ($4 x 50). Instead of marking up the 50 cases, the manager could report that only 30 are on hand, thereby reducing the markup to $120 ($4 x 30). That manipulation would create a pad of $80 ($200 - $120).

Too much emphasis is placed on procedural aspects of convenience store operations as the cause of inventory shortages. In reality, such procedural inaccuracies, either intentional or inadvertent, tend to conceal rather than expose shortages.

The primary cause of convenience store inventory shortages is employee theft. Two factors make convenience stores especially vulnerable. First, employees often work alone, particularly on the evening shifts, which eliminates any type of dual accountability or control. Second, many convenience store employees are young, part-time workers. The National Association of Convenience Stores estimates that 27 percent of all store employees are under 25. These employees often lack longterm career aspirations and company loyalty, factors that can also lead to increased shortages.

Most employee theft in convenience stores involves stealing cash at the point of sale. Employees steal in various ways, but almost all methods are variations of one central theme: failure to ring in sales. Let's look at some of the specific methods employees use to avoid ringing sales and see what happens when a sale is not recorded.

Perhaps the most common method is to use the no-sale key on the cash register. When a customer approaches the register to pay for merchandise, the cashier will use the no-sale key to open the cash register drawer.

By not ringing in the sale, the cashier has created a pad in the drawer that he or she will be able to steal, yet the register will still balance at the end of the shift. The theft won't be evident until the end of the audit period, when a physical inventory count is taken. At that time, the theft of cash will show up as an inventory shortage roughly equivalent to the retail value of the sales that were not recorded. There are certain clues, however, that will indicate when a cashier is stealing via the nosale method.

An inordinate number of no-sales on the cash register detail tape is one clue. However, it is impossible to come up with a definition of excessive no-sales that applies to all convenience stores. What is excessive at one store may be perfectly normal at another. And, there are legitimate reasons for using the nosale key, such as making change for video games, phone calls, and bus fares. But the idea is for store managers to keep track of no-sales to establish norms, then look for deviations.

If a cashier is using the no-sale key to steal cash, sales will fall, as will the number of customer transactions. Once again, store managers need to monitor sales to set norms, then look for deviations.

A third indicator of theft via the nosale method is excessive X tape readings. An X tape is a cash register report generated at the end of a shift that enables the cashier on duty to determine sales for the shift and the amount of cash that must be accounted for. A cashier needs to run only one X tape at the end of the shift to do the register closeout. If a cashier is taking any midshift readings, he or she may be trying to determine the cash surplus in the drawer as a result of not ringing in sales.

A calculator near the cash register is another sign. Employees use them to keep track of unrecorded sales so they know how much they can steal. Instead of calculators, some cashiers keep a list of subtotaled numbers, with each figure in the series of subtotaled numbers representing a sale that has not been rung in. Other dishonest cashiers place coins in the paper currency slots in the cash register as a rudimentary accounting mechanism, each coin representing the value of the bill in that slot.

Finally, the cash register display window is often blocked if employees are not ringing in sales. The employee's intent is to prevent the customer from seeing the no-sale pop up on the cash register. Some cashiers boldly tape paper or cardboard over the cash register display window, while others move large signs near the register to obscure the customer's vision.

Another major theft technique is underringing sales. A customer could, for example, approach the register with an $8 purchase. By ringing in that purchase as $.50, but collecting $8 from the customer, the cashier can steal $7.50 and the register will still balance. In some cases, cashiers under-ring sales for friends and relatives. Even though this form of under-ringing may not be done by the employee for personal monetary gain, the end result is the same: The store will show an inventory shortage at the end of the audit period when the physical count is taken.

MANY OF THE SAME SIGNS OF POSsible theft using the no-sale key-excessive X tape readings, the presence of calculators, and a blocked cash register window-are also used when employees underring sales. There is, however, one clue that is peculiar to underringing. When a cashier rings sales at less than actual retail value but collects the full amount from the customer, store sales will fall, but the actual number of customers who are served in the store will not fall. Therefore, at stores where a computerized cash register records the number of customers served, management should be on the lookout for a fall in total sales coupled with a steady, or even rising, number of customers served.

Some employees who steal at the point of sale use a technique known as working from an open cash drawer. They simply leave the cash register drawer open while taking money from customers and making change. If questioned by customers, the cashier will say the register is malfunctioning. Once again, sales are not being recorded when merchandise is leaving the store and, therefore, an inventory shortage appears when an audit is conducted.

Many people suggest that issuing a cash register receipt significantly deters theft at the point of sale, regardless of the method used. Theoretically that is true, and indeed cashiers should be required to give receipts to all customers, but most convenience store customers are in a hurry and do not want receipts. Dishonest cashiers know that and are willing to risk not ringing in sales.

In one case, a cashier who was caught stealing was asked what she did when someone wanted a receipt. She said customers rarely asked for receipts, but when they did, she told them the register tape was broken.

The fact that many convenience store customers neither wait nor ask for receipts opens the door for another type of theft. Say a customer enters a convenience store, makes a purchase for $9.99, and leaves the cash register receipt behind. Immediately after that $9.99 sale, a dishonest cashier could hit the return or void key, depending on the type of register, and enter $9.99. This creates a $9.99 credit to the register that will offset the legitimate $9.99 sale.

Next, the cashier will ring up another sale for $.99. The net effect will be to create a $9.00 cash surplus ($9.99 .99) in the register, which can be stolen from cash receipts. If questioned, the cashier will say he or she hit the incorrect register key but corrected the error, and the individual will have the cash register receipt as proof.

Identifying some of the main techniques used by dishonest cashiers to steal cash at the point of sale is relatively easy, but controlling the situation is more difficult. One deterrent used by many convenience store chains is charting and trending sales activity. This technique involves taking information from cash register detail tapes and transferring it to a company form where the data can be compared and analyzed. The following data should be collected daily for each shift:

* cashier on duty

* shift sales

* shift sales as a percentage of total sales

* cash register variance

* customer count

* returns, voids, over rings

* tape readings

* no-sales

Also included on the form should be notations about conditions such as snow, hurricanes, severe weather, early shift changes, driveway construction, and anything else that could be responsible for a change in normal activities. The store manager must analyze that data on a daily basis, look for unexplained deviations from the norm, and respond immediately.

One simple yet highly effective response to deviations is to rotate work schedules. For example, if third shift sales have dropped and the number of no-sales has increased since a particular cashier started working the third shift, move that cashier to another shift and see what happens. If sales suddenly rebound and the number of no-sales fall back to more normal levels, it could indicate that the cashier was stealing money by not ringing in sales.

Another response could be just to ask questions. Find out from the cashier if there is a logical explanation for the drop in sales and corresponding increase in the number of no-sales.

A word of caution when responding to deviations: Bring them up in a nonaccusatory manner. None of the theft indicators or deviations, taken collectively or individually, proves that theft has occurred. The goal of charting and trending is to recognize clues of theft and react in a way that lets dishonest cashiers know they risk being caught if they continue to steal.

This system of charting, trending, and responding to deviations is nothing more than a commonsense approach to controlling merchandise shortages. Despite its simplicity, it is a proven deterrent to point of sale theft, the cause of most convenience store merchandise shortages.

An aggressive program of unannounced, mid-shift cash audits, particularly during evening hours, also deters employee theft significantly. This method involves showing up at the store before the end of a cashier's shift to compare cash on hand to sales rung in the register. Also during a cash audit, visually inspect die register area for other clues such as calculators.

To determine total cash receipts, count the money in the register, add die money that was put in the safe during the shift, and deduct the cashier's opening cash fund or bank. Next, compare the calculated cash receipts against the sales shown on the register detail tape to see if there is a shortage or surplus of money.

But don't be misled by a cash overage. There is no legitimate way for a cashier to be "over" in the register. It is a strong indicator that the cashier failed to ring in sales and was intending to steal the excess money before the end of the shift.

Closed-circuit television (CCTV) can also deter employee theft at the point of sale, if used properly. However, CCTV is practically useless unless tapes are reviewed regularly. Videotapes must be reviewed in the context of the theft indicators previously discussed. A video recorder with a time and date generator makes that possible. If, for example, a cashier had an inordinate number of nosales on a shift, review the detail tape to ascertain when the no-sales were rung in, and review the corresponding portions of the videotape to see what took place at the register.

Several companies are now marketing cash register-CCTV interface devices, which make it easier to review tapes. These systems not only capture an image of the register detail tape for each transaction on the videotape along with the regular video image, but they also flag certain types of register activity.

Certain transactions such as no-sales and returns can be highlighted, so when the videotape is played in fast forward, a tone will sound whenever one of these transactions appears. The tone signals the tape reviewer to stop the tape and review that segment in detail for possible indications of theft.

Some companies use honesty shopping to uncover cashier theft. An honesty shopper typically makes what is known as a drop purchase. He or she enters a store, picks up a high-priced item, and approaches the register. Pretending to be in a hurry, the honesty shopper drops exact change on the counter and leaves the store without waiting for a receipt.

By noting the exact time and amount of the purchase, management can review the cash register tape to see if the sale was recorded. The drop purchase technique is effective because it gives cashiers who are likely to steal an opportunity to do so.

CAREFULLY MONITORING GROSS profit percentages is another big deterrent to employee theft. But, before talking about gross profit percentage GP%), a concept known as cost of goods sold (COGS) must be explained.

COGS is what a store paid for goods it acquired for eventual resale at a profit. COGS for a given audit period can be calculated by determining the cost of the opening inventory level (01 Cost), adding the cost of purchases (Purchases

Cost), and subtracting the cost of the ending inventory El a2 Cost). That is, COGS = 01 Cost + Purchases

Cost - El Cost

Once COGS has been determined, the following formula can be used to calculate GP%: GP% = (Sales - COGS) ' Sales

Say a store targets 40 percent as its desired GP% on merchandise sales. When it purchases merchandise for resale from suppliers, it will set the retail selling price of that product to reflect the desired GP%.

For example, if a store purchases an item for resale that costs $3, it will mark up that item so the retail selling price will yield a gross profit of 40%. By using the preceeding formula, the retail selling price of that item can be figured out. For example,

40%    =  (Sales -  $3) [divided]  Sales
Sales  =  $5.00  =      Retail Selling
                        Price of Item

At the end of an audit period the store can determine its sales and calculate COGS in the aggregate. By substituting into the same formula, the actual GP% earned on sales for that period can be calculated. The aggregate GP% based on actual retail sales should equal the targeted GP% used in setting the retail sale price of individual items. For example, if the store has total sales of $50,000 for a period and the COGS are $30,000, we can again use the formula to calculate the actual GP% earned on total sales for the period: GP% = (50,000 - 30,000) , 50,000 GP% = 40% As you can see, the actual GP% does in fact equal the targeted GP%.

However, employee theft can substantially erode that GP%. If a dishonest cashier fails to ring up $2,000 in sales in order to conceal the theft of a comparable amount of cash, sales for the period will fall to $48,000. Nevertheless, merchandise with a retail value of $50,000 actually was taken from the store by customers and must be replaced in inventory with new purchases. Consequently, COGS for the period will remain at $30,000. Substituting these new numbers into the formula and solving:

GP% = (48,000 - 30,000) [divided by] 48,000
GP% = 37.5%

As you can see, failing to ring up $2,000 in sales caused the actual GP% to fall to 37.5 percent, 2.5 percent less than the targeted GP% of 40 percent. A fall in GP% could admittedly be caused by many factors, but that erosion could also be attributed to theft. Security professionals must be mindful of that fact because reducing inventory shortages could be the easiest way to raise profits without increasing sales volume, raising prices, or cutting other costs.

Despite the simplicity of the concepts discussed, mastery of the basics can help us achieve the often elusive goal of reducing inventory shortage.